An investor buys a bond with the following characteristics:

• Maturity - 10 years
• Coupon - 4.5%, paid once per year
• Nominal Value - 100

The yield to maturity at the time of purchase is 8.50%. The investor sells the bond immediately after the sixth coupon payment, when the yield to maturity rises to 9.50%.

a.What is the investors realised annual rate of return after the sale of the bond, assuming that the investor can reinvest received coupons at the yield to maturity?

b.What is the Macaulay duration of the above bond, at the original time of purchase?

c.Use the modified Macaulay duration to calculate what the price of the above bond would have been immediately after purchase, if the yield to maturity had dropped to 6.5%.

d.An accurate answer for part (c) is 85.32. Explain why your answer to part (c) differs from this. What are the implications of this effect for bond investors?